Stephen Bobko-Hillenaar, Taylor Easley and Dale Suezaki are financial advisers with Morgan Stanley, 329-7979.
As we move through life, financial goals can change. For example, as investors get closer to retirement, they typically think about how they’ll fund their living expenses. For many investors, maintaining a steady income stream is a key focus for their retirement years. Customizing your portfolio to include fixed income securities can help you accommodate this goal.
How are your assets allocated?
Proper asset allocation is essential for investors looking to save for retirement. Asset allocation describes the percentage of an investor’s total financial assets invested in different investment categories, or “asset classes.” The major financial asset classes are stocks (equity), bonds (fixed income) and cash. Based on your risk tolerance and financial goals, you may wish to allocate a portion of your total assets to bonds. For example, many investors looking to generate an income stream invest a higher proportion of their portfolios in bonds.
What is a bond?
Bonds are debt obligations issued by governments, municipalities, agencies and corporations. The issuer promises to repay principal in full at the bond’s maturity, and to pay periodic interest income at a specified interest rate over the life of the bond. Bonds typically allow investors to anticipate interest and principal cash flow over time, while also providing maturity and flexibility to match investment needs.
Bonds are often used as an important component of a balanced portfolio. Through the diverse fixed income market, you can choose individual securities based on your specific investment goals and level of risk tolerance. Issuers such as the U.S government, municipalities and corporate entities allow diversification across industrial and geographic sectors and credit quality, while different maturity structures — from 1 year to 30 years — provide the ability to match securities to your financial time frame. And by choosing fixed coupon bonds you’ll receive a steady stream of interest income, usually on a semi-annual basis, until the bond matures. In addition, many investors use bonds to reduce exposure to the uncertainties of the equity market and to help protect the value of their portfolios through diversification. (Diversification does not guarantee a profit or protect against a loss in a declining financial market.)
Structuring your bond portfolio
If you are saving for retirement you may also want to consider implementing a laddered portfolio strategy. Using this strategy, you can diversify your holdings by including investments in short-, intermediate- and long-term fixed income securities; taking advantage of the higher liquidity of shorter-term securities while also attaining the higher returns typically available through longer-term securities. In addition, a laddered portfolio can provide a predictable flow of interest income and a level of price stability during turbulent interest rate cycles.
Consider the risks involved
Before you invest, remember that all fixed income securities are subject to risks that you should consider. In particular, bond prices are susceptible to interest rate fluctuations; generally, if interest rates fall, bond prices rise and, inversely, if interest rates rise, bond prices fall. Another point to remember: If you hold your bonds to maturity, your principal will be returned in full, but, if you sell your bonds prior to maturity the price you receive may be more or less than your original purchase price.
You should also consider every bond’s creditworthiness; if an issuer is unable to meet its financial obligations, it may fail to make interest and principal repayments. If you are looking to safeguard principal you should consider “investment grade” bonds (those rated Aaa/AAA through Baa/BBB by Moody’s Investors Service and Standard & Poor’s, respectively).
Lastly, reinvestment risk may impact your portfolio. This is the risk that the income stream from a given investment may be reinvested at a lower interest. It is especially evident during periods of falling interest rates, where coupon payments are often reinvested at a lower rate than the original instrument.
Achieving your investment goals
Every investor’s needs are unique. But regardless of your individual financial goals, the wide variety of choices in the fixed income market mean a tailored strategy can be created to help address your specific investment requirements. Your financial professional can help you determine the right fixed income investments for your investment portfolio.
Articles are published for general information purposes and are not an offer or solicitation to sell or buy any securities or commodities. Any particular investment should be analyzed based on its terms and risks as they relate to your specific circumstances and objectives.
Stephen Bobko-Hillenaar, Taylor Easley and Dale Suezaki are financial advisers with Morgan Stanley, 329-7979.